A letter to the Business Advisor
Dear Akin, Thanks for sharing great advice on business. Always very helpful. With rising prices in Nigeria and the resultant impact on the cost of doing business, can you advise how businesses can improve profits in an economy with such a high inflation rate like ours? And how did we even get here?
Michael. A.
Lagos
Dear Michael – Thanks for words. A country experiences inflation when there is a continuous increase in the general price of goods & services.
National Bureau of Statistics reported a 22.95% food inflation rate (18.17% ‘general’ inflation) in March 2021. It also reported an unemployment rate of 33% and a negative economic growth rate. The trio is what economists refer to as stagflation (i.e. stagnant economy experiencing inflation).
Nigeria’s stagflation was triggered by the COVID-19 pandemic, which induced a global drop in the price of crude oil, Nigeria’s primary source of income. This negatively impacted government revenue. Productivity also nosedived, particularly during the lockdown. The Central Bank has been printing more money to support government expenditure. There has, however, been no corresponding increase in national productivity. More money in circulation with low productivity then resulted in a situation often referred to as “too much money chasing too few goods”, leading to a general price
the
kind increase.
There are unintended consequences for businesses, of course. The cost of input (or raw materials) skyrockets. Domestic and foreign direct investments (FDI) decline. Customers have less disposable income, and those that are better-off are hoarding or converting their cash to more stable currencies, negatively impacting demand for domestic goods & services.
A sustained input price increase is not all bad news if the business can pass additional cost to customers. They are ultimately better off as they maintain the same margins on more expensive products.
Most businesses, however, are unable to do this. In such instances, it directly impacts the bottom line, significantly reducing their profits. Many go out of business.
Here are three (3) things businesses can do when prices of input increases:
Borrow cash: During inflation, lenders are worse off while borrowers enjoy the benefits. This is so because the real value of money (i.e. what it can buy) decreases with time. If the inflation rate is rising year on year and likely to continue on that trajectory, businesses should borrow money at fixed rates (avoid variable rates). This is particularly sound advice for businesses with high cash turnover because that is a hedge against inflation. Existing loans should be renegotiated, spreading them over more extended periods. The value of a currency drops rapidly as the inflation rate rises. When repaying loans, therefore, you are paying a fraction of the amount borrowed in real terms. If the loan is used for productive activities, your venture is ahead of the prevailing economic situation.
Buy Stocks: While businesses requiring high cash turnover may borrow, businesses should not hold cash that is not actively engaged. Instead, they should lock in the present value of their cash by investing in stocks of companies producing “essential products”. Demand for essential products usually remains strong throughout the period of inflation, improving their business performance. Stocks of these companies